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Doing trade barriers with my NCEA Level 2 class and below is a good clip from Al Jazeera about the issues that are arising from it and who will lose the least from a trade war. The last ten years saw a marked improvement in trade between the United States and China. But Trump’s battle of the tariffs is threatening that. And there are fears of an all-out trade war. The U.S. is putting tariffs on 50 billion dollars worth of Chinese imports. The president says he wants a fairer trade with China. But Beijing’s fired back with a tit-for-tat response. It’s published a list of more than 600 American products it plans to hit with its own taxes. Is it a case of who blinks first in this economic brinkmanship? And what will it mean for global trade? The comments by Philippe LeGrain are particularly good.

After a third round of trade talks between China and the US ended in stalemate a US$100bn trade war is on the horizon. America has published a list of 1,300 Chinese products which it proposes to hit with a 25% tariff. China has it own list covering 106 categories. As the Chinese embassy in Washington DC said “As the Chinese saying goes, it is only polite to reciprocate.” See graph below from The Economist.

Historians of trade have an advantage over those who study wars of the military kind. Each side is a trade dispute lays out in detail the products to be affected. That makes it easier to analyse their strategies. Trump’s blunt attack targeting of a particular industry – steel and aluminium – is to supposedly make the industry in the US stronger. China retaliated by placing tariffs on US$0.2bn-worth of iron and steel tubes, pipes and hollow profiles, and US$1.2bn-worth of aluminium waste.

The US face a trade-off between protecting their own industries with import tariffs at the same time as increasing the cost of goods for its consumers. There is also the likelihood of causing disruptions to the US economy by increasing the cost of intermediate goods (aircraft parts, robots, semiconductors) which ultimately leads to higher prices.

Good long-run deal for China

It seems that China has the dominant position for the following reasons:

China can stop purchasing US aircraft

Impose an embargo on US soybean products

Dump US Treasury Bills and other securities

Chinese companies could reduce demand for US business services

The government could persuade firms not to buy US products

China is indirectly one of America’s biggest employers. China could look to buy all it commercial aircraft from European consortium Airbus rather than Boeing. That move alone wold cost 179,000 US jobs. China controls key components in global supply and production networks

Initially a trade war would mean job losses for both countries but in the long-run with China looking to develop a more domestic led consumption model the export market becomes less significant – Project Syndicate. See video below:

Smog levels in Beijing were almost seven times the maximum exposure recommended by the World Health Organization. That makes the smog a matter of life and death. In the first quarter of this year more than 90 percent of Chinese cities failed to meet the government’s own air-quality standards.

Air pollution contributes to 17 percent of all deaths in China. As many as 1.6 million people died this year as a result of air pollution, the Berkeley Research Group estimates. That’s about 4,400 people dying every day. But what is the government doing to tackle the issue? And why has it failed to strike a balance between economic growth and public health?

Coal remains one of the easiest and cheapest form of energy and this is very apparent in India where usage is about 62% of energy needs. India is the second largest consumer after China and ahead of the USA. Also coal consumption is growing about 7 percent a year to power the country’s economic catch-up. As China is going through a growth period similar to Europe many years earlier, their argument will be that European countries polluted the environment by a similar amount

Climate change activists have highlighted concerns of rising temperatures by 2100, however are rising temperatures as significant when you consider the long-term implications of much higher unemployment?

The Belt and Road Initiative (BRI) is a development strategy proposed by the Chinese government that focuses on connectivity and cooperation between Eurasian countries. Through infrastructure development China wants to boost trade and stimulate growth across Asia and into Europe. Ratings agency Fitch said that $900bn in projects were planned or in progress.

India is a country that will benefit from this development and recently Prime Minister Modi positively responded to Chinese President XI Jinping’s vision of the world – the BRI being the most obvious and a catalyst to India’s foreign policy aims which responds to the global trends. These are:

India has the potential to become the world’s third largest economy by 2030. It intends to do this by sharing prosperity and working with other countries to set joint goals.

Political ideologies are now encompassing equity and environmental issues. In India they are becoming more main stream policies for government and sustainable resources use is important in the 21st century.

India is looking at Asia as the largest common market. Asia is reverting to its historical equilibrium of an integrated continent and does not want to choose between India or China. Instead, it supports a resetting of their relations to shape the goals of the ‘Asian Century’, which include the Bell and Belt Initiative and security related differences.

India has a comparative advantage in the digital world and the potential to be the engine behind global growth.

India priority is settling the boundary issues with its neighbours, enhancing diplomatic leverage and building a $10 million economy.

China is trying to improve international norms, technical standards and institutions through the BRI which covers more than 900 projects – 76 ports and terminals in 34 countries and special arbitration courts, about 80% which are contracted to Chinese companies. Whilst Prime Minister Modi is trying to divert the Western framework for reducing emissions in favour of human well-being within ecological limits.

And as the rivalry between the US, and Russia and China intensifies, India can play a stabilising role on agreed goals within the framework of a multi-stakeholder in the “Asian Century”.

China’s share of global trade has surged since the 1990’s with both exports and imports increasing significantly – see graph below. Exports have been on a steep rise since 2001 with only a slight plateau with the GFC in 2008-9.

On Friday Donald Trump signed an order to impose tariffs on as much as $60 billion worth of Chinese imports. Trump wants to punish Beijing what he said is “the theft of American technology and Chinese pressure on U.S. companies to hand it over.” This deficit is significant – largest deficit of any country (see graph) – and Trump is blaming the US China trade imbalance for the loss of jobs in the US. This is an area that Trump focused his attention on in his campaign and now he is trying to fulfill the rhetoric.

Source: National Australia Bank

China has already warned that it will take “all necessary measures” to defend itself, raising the prospect of a trade war between the world’s two biggest economies. China has a few retaliatory measures it could use:

Soyabeans – US or Brazil?
The United States exported more than 30 million tons of soybeans — worth more than $10 billion — to China last year, over 57 percent of total U.S. exports of the popular legume. The soybean industry is heavily subsidised by the US government and this allows them to dump their produce on the Chinese market below the Chinese market price. China could look to Brazil for soy.

Boeing or Airbus?
Boeing make over 50% of commercial aircraft operating in China. Last November they signed an agreement to sell 300 planes to China worth $37 billion. This order supports approximately 150,000 jobs. In future China could look to the European plane manufacturer Airbus.

Sorghum
Earlier this year Trump imposed the following on Chinese products:

20% tariff on the first 1.2m imported large residential washers in the first year, and a 50% tariff on machines above that number.

30% tariff will be imposed on imported solar panels

In retaliation China has launched an anti-dumping and anti-subsidy investigation into imports of the grain from the US. China is the top buyer of US sorghum – US provided 4.76 million of CHina’s 5 million metric tonnes of sorghum imports – US1.1bn. China could retaliate after its investigation wraps up, expected next February.

Apple
China is a major market for the iPhone maker. Apple also depends on China’s workforce to make most of its products. As a result, China’s government has enormous leverage over the company and could, as it has in the past, target Apple for violating Chinese consumer rights.

General Motors
The Chinese market is imperative for GM – China has been the largest retailer for the last 6 years. 4 million cars were sold in China last year, up from 4.4% from the previous high a year earlier. Chinese automakers like Geely and BYD are competing for market share, though, and China could make it more difficult for both GM and Ford to operate on Chinese soil. In late 2016, China fined GM’s China joint venture $29 million for “price fixing,” or setting minimum prices for certain Cadillac, Chevy and Buick models.

Norway’s soveriegn-weatlh fund surpassed US$11trn in assets on September 19th this year. With its significant revenue from North Sea oil and gas getting invested overseas it is likely to get even bigger to the extent that Norway can start to shape ideas abroad. It is increasingly speaking out on ethical behaviour of companies and is an increasingly activist shareholder. The ethics watchdog for the fund recommends that it excludes several firms in oil, cement and steel industries for emitting too much greenhouse gas. This may seem hypocritical in that Norway produces significant amounts of oil but it operates under its own ethical guideline set by parliament.

Source: The Economist – 23-9-17

Missing out on billions of dollars

Norway’s sovereign wealth fund has share in 9,000 companies, 1.3% of the entire world’s listed equity. It has lost out on billions of dollars of revenue by its government prohibiting any investment in tobacco companies and manufactures of certain weapons. The fund is forbidden by law from investing in firms that produce nuclear weapons or landmines, or are involved in serious and systematic human rights violations, among other criteria. These include Boeing, Airbus, Imperial Tobacco, Philip Morris. Last year the council looked into the construction industry in Qatar – host of the 2022 soccer World Cup – and neighboring countries, after reports of abuse by human rights groups. Since then new regulations have been implemented which protect the rights and living and working conditions of labour in the construction industry. This includes the right of immigrant workers to hold onto their passport. There is a broad consensus in Norway that the fund should not make money from companies that take people’s lives.

Norway and coase theorem

Another way Norway is trying to influence global warming is by using its sovereign wealth fund to change behaviors of other countries. Ronald Coase argued that bargaining between parties could produce a mutually beneficial and efficient solution to problems like pollution. An example of this was the a deal between Liberia and Norway. Norway will give $150m in aid in return for Liberia stopping the destruction of its forests.

Stick and Carrot

The stick approach of trying to force Liberia to stop cutting down its trees might give way to a more effective carrot approach by paying Liberia to do so. This makes both sides better off. Liberia still gets the aid and Norway gets to preserve biodiversity and take a small step against climate change.

5 or 6 more China’s

The reality is that the planet can’t stand another 5 or 6 China’s but developing countries still need to grow and, like their developed country counterparts, it will involve greenhouse gas emissions. If we are to curb global emissions developing countries will have to leapfrog to new technologies as the burning of traditional fossil fuels will just exacerbate the problem. However developing countries have neither the resources nor the incentive to reduce dependence on fossil fuels on their own as their main focus is economic growth. Whilst developed countries have a lot to lose from developing-world emissions it is in their interest to pay the latter to curb emissions e.g. Norway paying Liberia not to chop down its trees. Although this looks a simple enough policy politicians will not be so enthused by it as money that is paid overseas to cut climate change is not very popular with the electorate and therefore the government.

Economic growth is normally we associate growth with capital investment and a shifting out of the production possibility curve. The Chinese have implemented an alternative policy that entails cutting capacity of its steel and coal production by at least 10% over 5 years which will reduce global supply by 5%. The rationale behind this is that:

less supply = greater scarcity = higher prices = greater profits.

Although there have been doubters over this policy it seems to have worked. Coal and steel prices increased as have the profits in those industries and this has led global markets to be more positive about China’s economy. The higher prices has also reduced the threat of deflation coming out of China. Furthermore the Yuan has appreciated and nominal growth has close to a five year high.

Problems with this policy:

The higher price caused by reduced supply raised concerns that supply would lead to surplus capacity.

The underlying problem was that cheap loans were forthcoming from Chinese banks for certain projects run by state-owned firms. This can lead to an uncomfortable scenario with the firms being reckless as if their investment runs into trouble they will be bailed out by the government.

The reducing of output of steel and coal means a loss of 1.8m jobs which will concern Chinese authorities as a top priority has been to keep unemployment as low as possible and thereby limiting possible unrest that may follow.

On 7th April 2008 New Zealand became the first OECD country to sign a free trade deal with China, an economy which in the 1970’s was one of the poorest countries in the global economy. Today China is the world’s second largest economy and the fastest growing at a rate around 7% per year. However China’s trade composition has changed significantly over the years as its economy has developed. Two main trends stand out.

The decline in importance of primary goods (mainly food) as a proportion of China’s total commodity trade. China’s exports have changed from being dominated by labour-intensive manufactured products in the mid 1990’s to more sophisticated manufactures today. 1994 – 40.6% of exports were miscellaneous manufactured articles. 2014 45.8% of exports were machinery and transport equipment.

A changing comparative advantage

A country’s comparative advantage refers its production of a good or service at a lower opportunity cost than another. Instead of every country trying to produce a wide of goods , countries can grow faster by specializing in the goods they can produce most cheaply and trading for others. Many Asian countries – Japan, Korea, Taiwan – have gone through 4 stages (as shown below) of development through a specialization index. It shows the first stage is the Developing Country stage, where Primary commodities are more competitive than both Other manufactures and Machinery. The second and third stages are the young and mature NIEs (newly industrialised economies) respectively, where for both stages Other manufactures is the most competitive sector, but the ranking of Other manufactures vis-à-vis Machinery is opposite. At the fourth stage – the pinnacle of trade structures – Machinery is most competitive.

*NIE = Newly Industrialised Economy

A country’s trade structure can be classified into any of these 4 stages according to the relative magnitudes of the country’s specialisation indices across 3 sectors:

The figure below illustrates the evolution of China’s trade structure during 1984-2014. It can be seen that China became a young NIE in 1990 – when the specialisation index of Other manufactures surpassed that of Primary commodities – and then a mature NIE in 1999 – when Machinery passed Primary commodities. This pattern is consistent with the changing composition of China’s exports, from labour-intensive products to a more sophisticated mix led by various types of machinery and equipment.

Implications for the global economyChina’s rapid rise poses both challenges and opportunities for other countries as they are exposed to increased competition at home and abroad. For many firms in rich countries, intensifying competition from China’s exports has reduced demand for the goods they produce, with a corresponding decline in workers employed. Such changes in the global economic environment affect the allocation of factors of production and cause sectoral productivity fluctuations, as well as driving changes in comparative advantages among nations. Trade between developing (e.g. China) and developed economies (e.g. US) has been on the rise. Developed countries with high wages and expensive welfare programmes are having trouble coping with the effects of developing countries becoming major global players. It is estimated that 2.0-2.4 million people in the US lost their jobs as a result of increasing Chinese import competition during 1999-2011.

In 2000 the Chinese government introduced price supports for farmers with the floors raised annually to stimulate production even when global prices fell. There were three reasons for price supports:

ensure production of key commodities

provide a degree of food security

improve the well-being of farmers

China starts to abolish minimum prices

The last three years has seen the Chinese authorities start to abolish minimum prices for the following commodities – cotton, soybeans, corn and sugar. Without the minimum price the supply on the domestic market has dropped – grain production fell for the first time in 13 years. Remember with the minimum price being above the equilibrium it encourages producers to supply more but the demand will drop at the higher price.

When the minimum price was in operation the Chinese authorities had been stockpiling significant amounts of food and have been able to compensate for the reduction in supply from the farming community. However once these stockpiles have been diminished the only other alternative will be to import food which will be a positive for farmers from Brazil, US and Thailand. This might be sooner than later as the Chinese government is facing capacity challenges as warehouses and silos are overflowing but still China is not able to meet its domestic needs. According to the US Department of Agriculture, China is sitting on 54% of the world’s cotton stocks, 45% of the world’s corn and 22% of the world’s sugar reserves, but many analysts think that a lot of this stock is starting to perish.

Self-sufficiency in feeding the Chinese population still remains a priority for Beijing but after 2014 authorities have stated that they need to make rational use of the global agricultural market and import various food products. However China still spends a lot on supporting its agricultural sector:

2016 – $246.9 billion = 2.2% of GDP. Four times the average of OECD countries.

Although money is still spent on price supports a growing share is going into ways to improve productivity with R&D etc. China is in a position that they could revert back to the price supports if they feel the pain of reform is too great, but analysts think that they will be more accepting of global supply.

This policy of subsidising farmers is not unlike that of the European Union – see previous blog post ‘CAP reforms unlikely to benefit New Zealand farmers.’ – with the introduction of the Common Agricultural Policy (CAP). At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:

1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide fluctuations that often occur in the price of agricultural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.

CAP Intervention Price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

Investment in manufacturing by privately owned Chinese companies has increased from only 2 in 2000 to well over 150 in 2015 and 2016 and are transforming Africa’s economy by providing millions of jobs and encouraging a new generation of local entrepreneurs as well as attracting support from inspiring African institutions. Investment by the Chinese in Africa has usually been associated with natural resources or services but with manufacturing now being more prevalent industrialization is a growing possibility.

Chinese investment is about supply and demand

China sojourn into Africa is become more prevalent and has a lot to do with supply and demand. A generation under the one-child policy has had an impact on the supply of labour causing shortages to arise and ultimately wages – 12% annually since 2001 and productivity adjusted manufacturing wages nearly tripled from 2004 to 2014.

On the demand side Africa has started to integrate regional markets – in 2105 half the countries in Africa joined the Tripartite Free Trade Area, which will combine 600 million people in a single trading bloc, forming the 13th-largest economy in the world. The six nations of East Africa have created a single customs union – same as FTA but all member nations agree a set of standard tariff levels between themselves and outside nations. This is known as the Common External Tariff (CET). Nigeria boosts an enormous domestic market with high margins for companies as there is little competition. Also Lesotho enjoys tariff-free access to the US market and can take advantage of being close to the South African infrastructure.

Chinese companies in Africa employ locals

According to Justin Yifu Lin, a former chief economist at the World Bank. China is about to graduate from low-skilled manufacturing jobs which will free up nearly 100 million labour-intensive manufacturing jobs, enough to more than quadruple manufacturing employment in low-income countries. To put that into perspective, when manufacturing employment reached its peak in the United States, in 1978, only 20 million people had jobs in American factories. Now five times that number of jobs are about to migrate out of China.

By 2050 Africa’s population will reach 2 billion creating the largest pool of labour in the world. Today though some of the highest unemployment rates are in African countries – Nigeria 12.% with approximately 19% of the labour force being underemployed. However youth unemployment is just over 42%.
Although the media in Africa tend to portray an image that Chinese companies don’t employ local labour, recent analysis shows Chinese factories in Africa employ locals in large numbers – no research sample had a figure of local workers in a Chinese company lower than 78% and in some larger companies the figure exceeds 99%. In Nigeria 85% of workers hired by Chinese manufacturers are locals and 90% of workers in Chinese manufacturing and construction companies in Kenya are local.

The Flying Geese Paradigm

In developing economics the flying geese paradigm was the view of Japanese economists upon the technological development in Southeast Asia viewing Japan as a leading power. It states that manufacturing companies act like migrating geese, flying from country to country as costs and demand change. Factories from a leading country are forced by labour-price pressures to invest in a follower country, helping it accumulate ownership and move up the technology curve. This movement shifts the bulk of economic activity in the follower country from low-productivity agriculture and informal services to high-productivity manufacturing. The follower country eventually becomes a leading country, spawning companies in search of new production locations. The paradigm offers a convincing model of how Asian economies developed—in a chain from Japan to the Asian Tigers to China – see image above.

It describes not only the movement of companies from country to country, but also a process of industrial upgrading from product to product within each country – see image below. First a few companies show up to try their hands at making a certain product. As they learn, their profits attract other manufacturers of the same product. But as the field gets crowded, intensifying competition and thinning profits, some companies look for something else to make—this time something slightly more complicated and thus harder to copy. As the cycle repeats, companies that started by copying and learning are inventing and teaching a mere generation or two later. An analysis of 148 countries shows that as GDP rises, manufacturers within a country predictably move toward ever more complicated products. In another decade or two, factories in Africa will be churning out computers instead of ceramics and clothing.

Investment in manufacturing key to Africa’s development

For any economy to develop being more productive in the long run is the only way to create a higher standard of living. Manufacturing tends to become more productive over time as there is overseas competition from imports as well as having to compete in the export market. Furthermore manufacturing investment has a big multiplier effect – research shows that for every manufacturing job created, 1.6 service jobs follow.

Conclusion

Industrialization will allow Africa to follow in the footsteps of Japan, South Korea, Taiwan, and China: to build factories that employ its booming population and to refashion its institutions to meet the demands of modern capitalism. Most important, it will provide a real chance to raise living standards across broad sectors of the populace. If Africa could lift just half as many people out of poverty as China has in a mere three decades, it will eliminate extreme poverty within its borders. For nearly 400 million people, that would mean the difference between going hungry and being full, between scrounging for work and holding a steady job, between asking their children to do menial labor and sending them to school. The Chinese showing up in Africa today don’t doubt that this will happen. As one of them, who is working to build a special economic zone in Nigeria, said to me: “This is exactly like my hometown 30 years ago. If we could do it, then so can this place.”